Contours of Macroeconomic Policy in the Future
IMF Blog, April 2, 2015
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- Authors: Olivier Blanchard
- Published: April 2, 2015
Overview
- Seven years since the onset of the global financial crisis, policymakers and researchers continue to reassess how the crisis should change views about macroeconomic policy.
- The IMF organized two conferences, the first in 2011, the second in 2013, with proceedings published in two books, titled "In the Wake of the Crisis" and "What Have We Learned?".
- A third conference, "Rethinking Macro Policy III: Progress or Confusion?", is organized by Raghuram Rajan, Ken Rogoff, Larry Summers and Olivier Blanchard and will take place on April 15-16 at the IMF.
- The conference will focus on the architecture of policy when policy rates have become positive again and most countries are growing with stabilized debt-to-GDP ratios — i.e., how macro policy should look once the crisis is over.
Financial regulation
- Core diagnosis: the crisis resulted from the interaction of excessive leverage and extensive interconnectedness and complexity of balance sheets of both banks and non-banks, revealing large, undetected, systemic risks.
- Ongoing efforts: improving understanding and assessment of systemic risk.
- Key questions highlighted:
- Where do we stand in measuring systemic risk?
- Are some dimensions of systemic risk easier to measure (e.g., leverage in the banking sector vs. interconnectedness of banks and non-banks or risks outside the banking sector)?
- How should we assess the experience with stress-tests?
- Have we made enough progress in reducing systemic risk since the crisis, e.g., with Dodd-Frank, the Vickers commission, the Financial Stability Board, etc?
Macro Prudential Policies
- Definition: state-dependent regulations (example: maximum loan-to-value ratios adjustable with the housing market).
- Presumed role: targeted tools to handle many dimensions of financial risk, allowing fiscal and monetary policy to focus on traditional mandates.
- Practical challenges:
- Uncertainty about which tools to develop and how reliable their effects are.
- Political economy constraints (e.g., difficulty of increasing loan-to-value ratios during a housing boom).
- Evasion risk: financial actors will adjust to and try to circumvent regulation.
- Key questions and tradeoffs:
- Do we have or can we develop tools to deal with different types of risk (high housing prices, insufficient capital in some institutions, sudden drops in liquidity)?
- When should macro prudential tools be used versus tougher, non-contingent regulation?
- Should we aim for variable capital ratios and decide when to adjust them, or aim for high but constant capital ratios?
- In the game of cat and mouse, can regulators hope to win, or will regulation become increasingly complex and possibly counterproductive?
Monetary Policy
- Mandate debate: pre-crisis split between single mandate (price stability) and dual mandate (price stability and stable economic activity); the crisis revived calls for a triple mandate including financial stability.
- Coordination question: if financial regulation and macroprudential tools do not fully ensure financial stability, should monetary policy incorporate financial stability considerations? How should interest rates and other monetary tools interact with macroprudential policy? Should both be under central bank responsibility, and can central banks retain full independence if they wield sector-specific tools?
- Zero lower bound (ZLB) and negative rates:
- The ZLB was once seen as unlikely and easily countered by managing inflation expectations; experience shows that the ZLB can be reached, inflation expectations are not easy to manipulate, and exiting can take a very long time.
- Key questions: What can be done to avoid hitting the ZLB again? Are concerns about secular stagnation and low or negative equilibrium real interest rates justified?
- Quantitative Easing (QE) and balance sheets:
- Central banks expanded the set of assets purchased and vastly increased balance sheets.
- Key questions: Upon exit, should central banks revert to intervening at the short end or continue buying and selling longer maturity sovereign or corporate bonds? Should central bank balance sheets return to pre-crisis size or remain permanently larger? If intervening along the yield curve, how should monetary policy and Treasury debt management be combined?
- Extended lender-of-last-resort role:
- Central banks provided liquidity to banks, non-deposit taking institutions, and (directly and indirectly) to sovereigns.
- Question: Should central banks maintain such an extended role in tranquil times or revert to a narrower focus?
Fiscal Policy
- Role during crisis: when monetary policy was constrained, fiscal policy limited the decrease in demand and output, causing a dramatic increase in the debt-to-GDP ratio.
- Core issues for the future:
- What is a dangerous level of debt?
- How should fiscal space be conceptualized?
- Should fiscal accounting rely more on stochastic debt sustainability analysis?
- What are the multipliers associated with fiscal consolidation?
- What is known about confidence effects?
- Institutional and rule questions:
- EU fiscal rules are widely perceived as too complex and suboptimal; can better rules be designed?
- Should the fiscal golden rule or separation of current and capital accounts be resurrected, or is the abuse potential too large?
- Secular stagnation implications:
- If secular stagnation with excess saving implies negative real rates, does it make sense for governments to run larger deficits and increase public investment?
- Automatic stabilizers:
- Early crisis fiscal stimulus was instrumental in limiting output declines.
- Most countries allow automatic stabilizers, but they were not designed explicitly for stabilization; could they be improved, and why has there been little thinking about it?
Capital inflows, exchange rate management and capital controls
- Crisis lesson: international capital flows can be very volatile, with emerging markets particularly vulnerable.
- Policy responses: capital controls, macroprudential measures aimed at shaping flows, FX intervention.
- Key questions:
- What have we learned about the effectiveness of these tools?
- When should they be used and how should they be coordinated with the broader macro toolbox?
- Are there important differences between advanced economies and emerging markets in the use of these tools?
- What does experience since the crisis imply about the optimal opening of the capital account in the long run?
The International Monetary and Financial System
- Global dimensions of the crisis: central bank swap lines, IMF liquidity programs, large capital flows and exchange rate changes, talk of currency wars.
- Key systemic questions:
- Can we live with the existing system or can it be improved?
- Can cross-border financial regulation be designed and implemented to limit international arbitrage?
- Can the hybrid system of international liquidity provision (central bank swaps and IMF provision) be improved?
- Should the rules of the game for exchange rates be reexamined?
- How can sovereign debt restructuring processes be improved?
- What should be the role of international forums such as the G20?
Conference logistics and follow-up
- The conference is by invitation only due to space constraints, but the sessions will be webcast.
- Olivier Blanchard will attempt, in a post-conference blog, to summarize some of the wisdom coming out of the conference and provide tentative answers to some of the listed questions.
Source: Contours of Macroeconomic Policy in the Future, Olivier Blanchard, April 2, 2015.